The foundation for future growth comes from global outsourcing companies, which today are the most valuable component of the IT sector in Ukraine. Ukraine already today plays a critical role in the global IT ecosystem, with outsourcing being a multibillion-dollar market. Currently outsourcing is projected to grow from $2 billion in annual revenues to $4 billion in revenues in 2016. With an army of 50,000 software engineers, Ukrainian outsourcing companies can command valuations of $1 billion and higher. The country holds the fourth position in the number of certified IT specialists, following the United States, India and Russia.
Ukraine is an attractive destination due to its tremendous technical talent pool and lower development costs. Most of the clients are top European and Fortune 500 companies. The outsourcing industry has proved to be a boon, serving as a base for improving the competency of programmers and specialists, and providing salaries for technical talent that are high by Ukrainian standards. Local talented engineers systematically win various prestigious awards and are headhunted by the hottest Silicon Valley startups.
Ukraine also serves as a research and development hub for many multinational companies, including Google, Samsung, Seimens, Aricent, and Netcracker. Samsung alone has more than 1,500 engineers in Ukraine, while NetCracker has 700. We estimate the number of such R&D centers to be easily more than 100. Different from outsourcing, the R&D offices don’t just outsource development to Ukraine, but rather build centers for research & development of core technologies ranging from enterprise software to ecommerce platforms to mobile technology to games.
The Ukrainian startup scene was built upon the technical talent employed in the outsourcing industry. While the outsourcing companies may make startups more expensive to launch due to rising salaries, they have not blunted the transition from outsourcing to more product-focused companies. Companies are increasingly tapping into the growing domestic e-commerce market, which is projected to grow from $2 billion to $10 billion in 5-6 years. The nation of 46 million people has moderate Internet penetration of 40 percent, but is expected to reach Western levels of 70-80 percent in 5-7 years. E-commerce penetration reached roughly 2 percent this year and online retail will continue to grow at 40-50 percent annually. We expect the size of the e-commerce market to grow from $2 billion in 2013 to more than $10 billion in 5-6 years.
Ukrainian startups are increasingly learning the sales, marketing and scaling skills necessary to exploit global niche markets. Ukraine has many unpublicized success stories. The fastest growing segments of the e-commerce market in Ukraine in 2012-13 were e-travel and fashion. Leading companies were startups three years ago, but by the end of 2015 these companies will collectively reach $100 million in net revenue. Ukraine has the potential to produce many more promising startups.
Many startups are already world-class companies with superb management teams and products that are category leaders in their global niche. Depositphotos, a micro photo stock company, had $12 million revenue in 2013. It successfully competes with its U.S. public competitor ShutterStock. Belarusian Epam and Russian Luxoft are two outsourcing companies that also went public. Both companies still have significant numbers of employees in Ukraine. Last year, Google acquired Viewdle, a video face recognition company, for about $50 million. Typically, U.S. global companies remain key acquirers of successful software technology companies originating from Ukraine. We expect 3-4 Ukrainian companies to go public in the next five years.
However, a crucial factor holding back growth has been the lack of investment capital. In recent years, a few incubators in the mold of Silicon Valley institutions began to appear on the scene and make seed-stage investments. A TA Ventures fund that primarily invests in U.S. and European Union markets also began investing in Ukrainian e-commerce startups. AVentures Capital has invested in four Ukrainian companies this year. Russian venture firms, including Runa, Almaz, and global fund Intel Capital also began making investments in Ukrainian startups and financed a few deals in Ukraine.
Despite this, the overall level of investment in Ukrainian startups is still substantially less than in Russia. This has forced Ukrainian entrepreneurs to face stark choices very early in the company life cycle: to break even and become profitable very quickly, or to die fast. It is therefore not surprising that 33 percent of the 54 startups looked at were of the classic bootstrapped variety, built on small initial investments from the founders and reinvested profits. Another 32 percent of startups first attracted investments ranging from hundreds of thousands of dollars to the low millions, and then grew with their own resources.
This environment has forced entrepreneurs to produce only highly demanded products with fast monetization opportunities. More than 60 percent of these startups are operationally profitable businesses, a very high rate for early stage tech companies. This has, nonetheless, severely skewed company formation away from capital-intensive startups, which may require multiple rounds of financing before seeing a profit.
However, as more investment capital becomes available, this situation is rapidly changing. Venture firms are beginning to take notice of Ukraine and more institutional capital is entering the country. With still relatively attractive valuations, room for significant growth and a strong base of technical talent, Ukrainian startups are primed to take off in all IT segments. Ukraine is an unplowed field for investments in the IT sector. The nation has vast untapped potential and a pool of globally minded entrepreneurs looking for the capital that will help them launch their startups and exploit markets.
Yuliya Sychikova is the founder and CEO of Mittenpay.com and Yevgen Sysoyev is a managing partner of AVentures Capital.
